The Waves of 2011

One of the founding myths of the modern global financial system was that governments,
especially of the developed democracies, could borrow endlessly without consequence.
But, with sovereign debt crises erupting across the globe, it appears that
the umbrella of perceived safety has gotten smaller, exposing some benighted
countries, like Greece and Ireland, to severely rough weather.

As a key condition for financial rescues of these ailing sovereigns, the International
Monetary Fund (IMF) and the European Central Bank (ECB) both demanded severe
cuts in government spending. Faced with a bondholder revolt that sent yields
upward, both acquiesced and have embarked on austerity campaigns to repair
their financial positions.

The big question is: has the umbrella stopped shrinking, or will other countries
soon face similar decisions?

For now, major governments such as the US and EU have been able to continue
to borrow and spend licentiously to fend off the threat of deflation and keep
their economies stimulated (the US is by far the greater offender). But three
surprising and powerful changes threaten the viability of a long-promised "exit
strategy."

First, international investors are beginning to become net sellers of sovereign
debt. Even the mighty United States is finding that, despite the Fed's rounds
of massive quantitative easing, in which the Fed has bought outright hundreds
of billions of dollars of US Treasuries, yields are still rising. In other
words, the private and foreign selling pressure is stronger than the Fed's
buying pressure.

Second, the credit agencies, stung by their failure to warn investors about
the banking crisis, are now emboldened enough to threaten the triple-A ratings
of member states within the EU, and even of the United States itself - now
the largest debtor in the world. Although it remains to be seen how great an
impact the rating agencies will have on the debt markets, the fact that such
moves are being contemplated at least drives the debate in an unprecedented
direction.

Third, there is considerable and growing political pressure on governments
to cut spending. There is a growing awareness among Western voters that government
largesse can't be maintained forever, and that it will likely cost the next
generation if not the present. Many pet spending programs, including defense,
healthcare, welfare and even public pensions, are getting ready for haircuts
- if not scalpings. Massive government spending cuts, possibly accompanied
by tax increases, will be sure to take a huge bite out of near-term GDP growth,
and will perhaps put the world back into the second act of a recession. This
will lead us to the next great crossroads in the global financial crisis. Put
simply, will the governments of Europe and America allow a natural contraction?

If the central banks of the EU and the US choose to unleash even more massive
reflationary programs, then a period of crippling inflation could be the outcome.
This will form the basis of monetary chaos and prolonged economic stagnation,
the most damaging of all economic conditions. In these circumstances, the prices
of needed raw materials and commodities, including precious metals and energy,
would explode in dollar terms. [For those looking to gain investment exposure
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Meanwhile, Chinese inflation is beginning to drive the international agenda.
In order to keep a lid on this growing problem, China will soon have no choice
but to revalue its currency, the yuan, higher. This will curb inflation and
make most commodities cheaper in domestic terms. It will also satisfy the increasingly
angry political calls of other nations for China to revalue.

A yuan revaluation requires a devaluation of other key currencies, most dramatically
the US dollar, but also the pound sterling and euro. This will raise prices
for food, energy, and other necessities even in the absence of action by our
central banks. Such an outcome will place further economic pressures on the
developed West.

In conclusion, 2011 likely will open with a deepening recession, increasing
austerity, and falling asset prices. If this is met by a new round of inflation
creation and yuan revaluation, then investors should weigh whether to redeploy
assets in anticipation of potential rising commodity prices. I expect these
developments not to happen gradually, but to come in great waves. Smart investors
will tie their fate to an investment vessel with a solid hull, because in these
seas, even a hint of rot could tear a ship asunder.

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John Browne is the Senior Economic Consultant for Euro Pacific
Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament
who served on the Treasury Select Committee, as Chairman of the Conservative
Small Business Committee, and as a close associate of then-Prime Minister Margaret
Thatcher. Among his many notable assignments, John served as a principal advisor
to Mrs. Thatcher's government on issues related to the Soviet Union, and was
the first to convince Thatcher of the growing stature of then Agriculture Minister
Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously
pronounced that Gorbachev was a man the West "could do business with." A graduate
of the Royal Military Academy Sandhurst, Britain's version of West Point and
retired British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military,
John has a significant background, spanning some 37 years, in finance and business.
After graduating from the Harvard Business School, John joined the New York
firm of Morgan Stanley & Co as an investment banker. He has also worked
with such firms as Barclays Bank and Citigroup. During his career he has served
on the boards of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co.
and the former editor of NewsMax Media's Financial Intelligence Report and
Moneynews.com. He holds FINRA series 7 & 63 licenses.